# Apyx Medical Corp: Form 10-K for the period ended Dec 31, 2010 - Company: [Apyx Medical Corp](/companies/apyx.md) (CIK 719135) - Form: 10-K - Filed: 2011-03-31 - Accepted by EDGAR: Mar 31, 2011, 06:49 ET - Period: 2010-12-31 - Accession: 0001140361-11-019571 - Inline XBRL: no - Main document: https://www.sec.gov/Archives/edgar/data/719135/000114036111019571/form10-k.htm - All documents and exhibits: https://www.sec.gov/Archives/edgar/data/719135/000114036111019571/ ## Business As filed, 20,627 characters. ### General Bovie Medical Corporation (“Company” or “Bovie”) was incorporated in 1982, under the laws of the State of Delaware and has its principal executive office at 734 Walt Whitman Road, Melville, New York 11747. We are actively engaged in the business of developing, manufacturing, and marketing medical products and devices with a strong emphasis in electrosurgical generators and electrosurgical disposables. We sell a broad range of products designed for doctor’s offices, surgery centers and hospitals. ### Significant Subsidiaries Aaron Medical Industries, Inc. is a wholly-owned Florida corporation based in Clearwater, Florida. It is principally engaged in the business of marketing our medical products. Bovie Canada ulc (a wholly-owned subsidiary of Bovie Holdings, LLC, which is wholly-owned by us) an Alberta, Canada Corporation had a facility located in Windsor, Ontario, which was consolidated into our U.S. operations during 2010 and the operations were moved to our Clearwater, Florida facility. ### Industry We believe the medical device industry, although it can be challenging and very competitive, will continue to have a long term growth outlook with the number of surgical procedures performed increasing annually as a result of the aging “baby boomer” population. Additionally, we also anticipate a continued increase in minimally invasive surgical procedures due to ongoing advancements in technology coupled with continued overall pressure to reduce healthcare costs via a reduction in patient trauma and recovery time. Expanding global markets will also continue to provide growth opportunities for the medical device industry. ### Business Strategy We manufacture and market products, both under private label and the Bovie brands (Aaron®, IDS™, and ICON™), to distributors worldwide. Additionally, Bovie has original equipment manufacturing (OEM) agreements with other medical device manufacturers. These OEM and private label arrangements and our use of the Bovie brands allow us to gain greater market share for the distribution of our products. In 2010 we have continued the development of new products and submitted 510K’s to the Food and Drug Administration (“FDA”) for the Seal-N-Cut™, A1450™ generator, and our J-Plasma™ handpiece. We received 510K clearance for our ICON™ VS generator in 2010. During 2010, after evaluating the future outlook of our patent related to our SEER™ product line, we determined that the asset value was impaired and further calculated the impairment loss to be approximately $1.3 million. Subsequently, as a condition to our March 3, 2011 settlement with Salient Surgical Technologies, Inc. and Medtronic, Inc., we agreed to to immediately exit and not enter into the monopolar and bipolar saline-enhanced RF device business (including SEER™ and BOSS™) worldwide through February 2015 (see ITEM 3. “Legal Proceedings”). The terms of this settlement also included a provision for a possible OEM contract manufacturing relationship between Salient and our company, subject to requisite due diligence. In the past couple of years we have experienced a trend of longer than usual timeframes related to new products moving through the FDA clearance process. This trend coupled with the complexity of the new innovations and our high product standards have resulted in development times longer than initially anticipated. However, during 2010 we continued to make substantial progress in all of our new products along with further discovery of potential new applications, benefits, and uses for our J-Plasma™ product line. Cautery sales remained flat from 2008 to 2009 but trended up in 2010. Our electrosurgery sales saw an approximate 9% upward trend in our generator sales in 2010 over 2009, however we also experienced a downward trend in our electrosurgery disposables of approximately 14% due mainly to a reduction in sales of an OEM product line in 2010 over 2009. ### Company Products We group our products into three main categories: electrosurgery, cauteries, and other products. Information regarding sales by product categories and related percentages is included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this report (page 21) and is incorporated by reference herein. ### Electrosurgery Products Electrosurgery is our largest product line and includes desiccators, generators, electrodes, electrosurgical pencils and various ancillary disposable products. These electrosurgical products are used during surgical procedures in gynecology, urology, plastic surgery, dermatology, veterinary, and other surgical markets for the cutting and coagulation of tissue. It is estimated that 80% of all surgical procedures performed worldwide are accomplished by electrosurgery. Our electrosurgery products fall under two categories, monopolar or bipolar. Monopolar products require the use of a grounding pad attached to the patient for the return of the electrical current, while bipolar products consist of two electrodes; one for the inbound current and one for the return current and therefore do not require the use of a grounding pad. *Aaron® 900 and Aaron® 940* These products are low powered (30 and 40 watt) and high frequency desiccators. These units were designed primarily for dermatology and family practice physicians. The units are used mainly for removing small skin lesions and growths as well as for office based coagulation. *Aaron® 950* Bovie has developed a high frequency desiccator with cut capacity for outpatient surgical procedures. These generators allow physicians to change the power settings with one action. They were designed mainly for use in doctors’ offices and are utilized in a variety of specialties including dermatology, gynecology, family practice, urology, plastic surgery and ophthalmology. *Aaron ®1250U* We have also developed a 120-watt multipurpose electrosurgery generator. The unit features monopolar and bipolar functions with pad sensing. This generator was recently redesigned to allow one unit to work with a line voltage ranging from 100 – 240 VAC whereas previously there was a need for three different versions. *Aaron ®2250 / 3250 and IDS™ 200 / 300 / 400* Given the market interest in more powerful electrosurgical generators, we have developed 200, 300 and 400-watt multipurpose digital electrosurgery generators designed for the rapidly expanding surgi-center market and the hospital market. The digital hardware allows very high parallel data processing throughout the operation. All data is sampled and processed digitally. For the first time in electrosurgery, through digital technology, we are able to measure tissue impedance in real time (5,000 times a second). These units have been designed based on a digital feedback system. Bovie is using dedicated digital hardware instead of a general purpose controller for processing data. As the impedance varies, the power is adjusted to deliver a consistent clinical effect. The IDS™ 200 / Aaron® 2250 have the capability to do most procedures performed today in the surgi-center or outpatient settings and was introduced in 2003. Although 200 watts is more than enough power to do most procedures in the operating room, 300 watts is considered the standard and believed to be what most hospitals and surgi-centers will require. Therefore, we developed the IDS™ 300/ Aaron® 3250. The Bovie® IDS™ 400 is a 400 watt generator designed primarily for sale in the overseas markets. These units feature both monopolar and bipolar functions, have pad and tissue sensing, plus nine blended cutting settings. *ICON™ GI and ICON™ GP* The ICON™ product lines are innovative, custom designed specialty electrosurgical generators that incorporate an easy to use touch-screen interface which provides the user flexibility in achieving a desired effect through different digitally built-in modes. In addition, the ICON™ product line was designed to improve safety and convenience by requiring the use of only split pads with digital technology to protect against pad burns. It features specialized error messaging to prevent misinterpretation and allows for quicker troubleshooting, and has specialized audible alerts to indicate improper cable connections. The ICON™ line represents a new foundation platform that can be readily expanded thereby reducing the development time and cost for future new specialized generators and also allowing the user to easily upgrade existing units. The ICON™ GI is designed for the gastrointestinal (“GI”) niche market, while the ICON™ GP is designed for a more general purpose market like hospital operating rooms, surgery centers, etc. *Resistick™ II* Resistick™ II is a coating that is applied to stainless steel which resists eschar (scab or scar tissue caused by burning) during surgery. The coated electrodes continue the expansion of the Bovie® line of electrosurgical disposables. Since its introduction in June, this product has sales of approximately $348,000 in 2010. *SEER™ line* During 2010, after evaluating the future outlook of our patent related to our SEER™ product line, we determined that the asset value was impaired and further calculated the impairment loss to be approximately $1.3 million. Subsequently, as a condition to our March 3, 2011 settlement with Salient Surgical Technologies, Inc. and Medtronic, Inc., we agreed to to immediately exit and not enter into the monopolar and bipolar saline-enhanced RF device business (including SEER™ and BOSS™) worldwide through February 2015 (see ITEM 3. “Legal Proceedings”). ### Cauteries #### Battery Operated Cauteries Battery operated cauteries constitute our second largest product line. Cauteries were originally designed for precise hemostasis (to stop bleeding) in ophthalmology. The current use of cauteries has been substantially expanded to include sculpting woven grafts in bypass surgery, vasectomies, evacuation of subungual hematoma (bleeding from a smashed fingernail) and for arresting bleeding in many types of surgery. Battery operated cauteries are primarily sterile one-time use products. Bovie manufactures one of the broadest lines of cauteries in the world, including but not limited to, a line of replaceable battery and tip cauteries, which are popular in overseas markets. ### Other Products #### Battery Operated Medical Lights We manufacture a variety of specialty lighting instruments for use in ophthalmology as well as specialty lighting instruments for general surgery, hip replacement surgery and for the placement of endotracheal tubes in emergency and surgical procedures. We also manufacture and market physicians’ office use penlights. #### Nerve Locator Stimulator Bovie manufactures a nerve locator stimulator primarily used for identifying motor nerves in hand and facial reconstructive surgery. This instrument is a self-contained, battery-operated unit, individually packaged sterile, for one time use. ### Research and Development and New Products Our research and development activities are an essential component of our efforts to develop new innovative products for introduction in the marketplace. New and improved products play a critical role in our sales growth. We continue to place emphasis on the development of proprietary products and product improvements to complement and expand our existing product lines. We maintain close working relationships with physicians and medical personnel in hospitals and universities who assist in product research and areas of development. Our research and development activities are primarily developed internally. #### Disposable laparoscopic instruments Disposable laparoscopic instruments that are available in over thirty different jaw patterns and lengths, including ratcheted and non-ratcheted and offer the physician the quality of a reusable instrument with the convenience of a disposable. The instruments were released to our representatives in late February 2011 and have already been evaluated and purchased by physicians from a diverse group of specialties such as Gynecology, General Surgery and Urology. *Aaron® 1450* The Aaron® 1450-RF is a high frequency generator designed for surgery in the doctor office setting. This unit operates at 4 MHz, eight times higher frequency than a standard electrosurgical generator which operates at approximately 500 KHz. This unit is intended to be the first in a family of 4MHz generators initially designed for several office based specialties. The 1450-RF has been designed to include universal power control which allows the unit to be used in any power setting world wide. Subsequently, in March 2011, the FDA identified deficiencies in the original 510k submission and outlined several unresolved issues that need to be addressed. We will perform additional testing and evaluations to resolve the issues that were raised during the review. We plan to include this information in a new 510k submission. *Seal-N-Cut™ Handle and Accessories* The Seal-N-Cut™ is a new disposable endoscopic surgical handle that supports a plurality of electrical and mechanical modes. This technologically advanced endoscopic device will target the growing vessel and tissue sealing and cutting market. Due to recent device design improvements, we currently anticipate that we will have to re-submit the application for 510k approval in the third quarter 2011. *ICON™ VS* This generator expands further on our ICON™ platform which incorporates a flexible and simple user interface and allows for customization of the output modes for a variety of electrosurgical applications. This product, like the ICON™ GI and GP, its predecessor generators, is designed and being developed to add safety features and improve convenience in performing general purpose procedures and includes a vessel sealing component. This generator will also be used with our Seal-N-Cut handle and accessories. We have received 510K FDA clearance to market the ICON™ VS. *ICON™ GS (J-Plasma)* Our J-Plasma™ technology is the foundation for the ICON™ GS plasma system, which utilizes a gas ionization process producing a stable thin focused beam of ionized gas that can be controlled in a wide range of temperatures and intensities, providing the surgeon greater precision, minimal invasiveness and an absence of conductive currents during surgery. The development of this new gas system generator also includes the design of a new proprietary handpiece. We have received 510K FDA clearance to market the ICON™ GS. We have submitted a 510k application to the FDA for our J-Plasma handpiece with retractable cutting features for both laparoscopic and open procedures, which application is currently pending. In addition, we have filed patent applications on enhancements beyond the original patented technology. *MEG™ Handle and Accessories* These modular forceps are ergonomically designed to provide surgeons added comfort and improved safety while reducing per-procedure costs. We launched our first generation of the MEG line in 2009, however after some market feedback we have suspended sales of the product line pending further evaluation. *BOSS™ product lines* As a condition to our March 3, 2011 settlement with Salient Surgical Technologies, Inc. and Medtronic, Inc., we are required to immediately exit and not enter into the monopolar and bipolar saline-enhanced RF device business (including BOSS™) worldwide through February 2015 (see ITEM 3. “Legal Proceedings”). ### Sales & Marketing The majority of our products are marketed through medical distributors, which distribute to more than 6,000 hospitals and to doctors and other health-care facilities. New distributors are contacted through responses to our advertising in international and domestic medical journals and domestic or international trade shows. International sales represented approximately 21% of total revenues in 2010 as compared with 16% in 2009 and 17% in 2008. Our products are sold in more than 150 countries through local dealers which are coordinated by sales and marketing personnel at the Clearwater, Florida facility. Recently, in anticipation for the launch of our new surgical suite product lines, we have established a network of approximately 50 commission-based direct sales contractors to market and sell these products. Our business is generally not seasonal in nature. ### Competition We compete with numerous manufacturers and distributors of medical supplies and devices, many of which are large and well established. We sell our products and compete in various ways including by private labeling some of our products for major distributors under their label, and selling the majority of our other products through distributors. Private labeling allows us to increase our position in the marketplace and thereby compete from two different approaches, our Aaron® or Bovie® label, and our customers’ private label. Our private label customers distribute our products under their name through their internal sales force. Selling the majority of our other products through distribution increases our sales potential and helps level the playing field in regards to our larger competitors as most of the companies we compete with sell direct. Domestically, we believe, we have a substantial market share in the field of electrosurgical generator manufacturing which consists of our Company label and OEM units. We sell our products and compete with other manufacturers in various ways. Our main competitors are Valleylab (a division of Covidien), Conmed and Erbe Electromedizine, in the electrosurgery market, Xomed (a division of Medtronics), in the battery operated cautery market, and Ethicon and U.S. Surgical in the endoscopic instrumentation market. We believe our competitive position did not change in 2010. ### Intellectual Property We rely on our intellectual property that we have acquired over recent years including patents, trade secrets, technical innovations, and various licensing agreements to provide our future growth and build our competitive position. We own 12 patents and 16 trademarks in the U.S. Some of our early patents are nearing the end of their patent term. We also have filed a number of U.S. and international patent applications for various new products. As we continue to expand our intellectual property portfolio we believe it is critical for us to continue to invest in filing patent applications to protect our technology, inventions, and improvements however, we can give no assurance that competitors will not infringe on our patent rights or otherwise create similar or non-infringing competing products that are technically patentable in their own right. ### Manufacturing and Suppliers We are committed to producing products of the highest quality and technical advancements. We manufacture the majority of our products on our premises in Clearwater, Florida which is certified under the ISO international quality standards and may be subject to continuing regulation and routine inspections by the FDA to determine compliance with regulations in our quality system, medical device reporting, and FDA restrictions on promoting products for unapproved or off-label uses. In addition, we are also subject to regulations under the Occupational Safety and Health Act, the Environmental Protection Act and other federal, state and local regulations. ### Customers We sell the majority of our current products through major distributors which include Cardinal Health, Independent Medical Co-Op Inc.(IMCO), McKesson Medical Surgical, Inc., Medline, National Distribution and Contracting Inc. (NDC) (Abco, Cida and Starline), Owens & Minor, and Physician Sales & Service (PSS) and have manufacturing agreements for private label of certain products with Arthrex and others. In fiscal 2010, Arthrex orders represented approximately 11% of our total revenues. As we experienced in 2010 over 2009 with a reduction in OEM ablator sales, should Arthrex determine to reduce or cease placement of orders for their products, our business will likely be adversely affected. ### Backlog The dollar value of unshipped factory orders is not material. ### Employees At December 31, 2010, we had 143 full-time employees consisting of 5 executive officers, 21 supervisory personnel, 9 sales personnel, and 108 technical support, administrative, and production employees. None of our current employees are covered by any collective bargaining agreement and we have never experienced a work stoppage. We consider our employee relations to be good. ## Risk factors As filed, 34,566 characters. In addition to risks and uncertainties in the ordinary course of business, important risk factors that may affect us are discussed below. Additional risks not presently known to us or that we currently believe are immaterial may also significantly impair our business operations, ### Risks Relating to Our Business ***Current challenges in the credit and capital markets may adversely affect our business and financial condition.*** The current global economic crisis described below should also be considered when reviewing each of the subsequent paragraphs setting forth the various aspects of our business, operations, and products. The recent global economic and financial market crisis has caused, among other things, a general tightening in the credit and capital markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and lower consumer and business spending. Although the ultimate outcome of these events cannot be predicted, they may have a material adverse effect on us and our ability to raise capital or borrow money in the credit markets and potentially to draw on our revolving credit facility or otherwise obtain financing. Similarly, current or potential customers and suppliers may no longer be in business, may be unable to fund purchases or may decide to reduce purchases, all of which could lead to reduced demand for our products, reduced gross margins, and increased customer payment delays or defaults. Further, suppliers may not be able to supply us with needed raw materials on a timely basis, may increase prices or go out of business, which could result in our inability to meet customer demand in a timely manner or affect our gross margins. We are also limited in our ability to reduce costs to offset the results of a prolonged or severe economic downturn given certain fixed costs associated with our operations. ***We do a substantial amount of business with certain original equipment manufacturers (“OEM”) which as a group have produced substantial revenues for our Company. Loss of business from a major OEM customer will likely adversely affect our business.*** We manufacture the majority of our products on our premises in Clearwater, Florida. Labor-intensive sub-assemblies and labor-intensive products may be out-sourced to our specification. Although we sell through distributors, we market our products through national trade journal advertising, direct mail, distributor sales representatives and trade shows, under the Bovie name, the Bovie/Aaron name and private label. Major distributors include Cardinal Health, IMCO, McKesson Medical Surgical, Inc., Medline, NDC (Abco, Cida and Starline), Owens & Minor, and Physician Sales & Service. If any of these distributor relationships are terminated or not replaced, our revenue from the territories served by these distributors could be adversely affected. We have a major OEM customer, Arthrex, Inc., for which we manufacture products on a private label basis, pursuant to two agreements one for generators and one for accessories. On August 31, 2007, we amended and extended both manufacturing agreements for an additional three-year period. The amended terms continue to provide that we will be reimbursed for our expenses in developing any changes or modifications to products according to Arthrex’s specifications, and that Arthrex continues to own its intellectual property. In addition, general provisions for product warranties, insurance, termination, and confidentiality remain the same. The main change to the amended manufacturing agreement is the elimination of the provision that required Arthrex to exclusively purchase the products from us as well as the elimination of the provision that prohibiting our competing in the same Arthrex markets with said products. This amended Arthrex Agreement has terminated as of December 6, 2010 and March 2011 for the generators. In fiscal 2010, Arthrex orders represented approximately 11% of our total revenues. As we experienced in 2010 over 2009, should Arthrex determine to reduce or cease placement of orders for the products, or decline to extend or review its agreements with us, our business will likely be materially and adversely affected. We are also dependent on other OEM customers who have no legal obligation to purchase products from us. Should such customers fail to give us purchase orders for the product after development, our future business and value of related assets could be negatively affected. Furthermore, no assurance can be given that such customers will give sufficient high priority to our products. Finally, disagreements or disputes may arise between Bovie and its customers, which could adversely affect production and sales of our products. ***We rely on certain suppliers and manufacturers for raw materials and other products and are vulnerable to fluctuations in the availability and price of such products and services.*** Fluctuations in the price, availability, and quality of the raw materials we use in our manufacturing could have a negative effect on our cost of sales and our ability to meet the demands of our customers. Inability to meet the demands of our customers could result in the loss of future sales. In addition, the costs to manufacture our products depend in part on the market prices of the raw materials used to produce them. We may not be able to pass along to our customers all or a portion of our higher costs of raw materials due to competitive and marketing pressures, which could decrease our earnings and profitability. We also have informal collaborative arrangements with three foreign suppliers under which we request the development of certain items and components and we purchase them pursuant to purchase orders. Our purchase order commitments are never more than one year in duration and are supported by orders from our customers. ***If we are unable to protect our patents or other proprietary rights, or if we infringe on the patents or other proprietary rights of others, our competitiveness and business prospects may be materially damaged.*** We own 12 U.S. patents and 16 registered U.S. trademarks with some of our early patents nearing the expiration of their patent term. We also have several U.S. and international patent applications pending for various new products. We intend to continue to seek legal protection, primarily through patents, for our proprietary technology. Seeking patent protection is a lengthy and costly process, and there can be no assurance that patents will be issued from any pending applications, or that any claims allowed from existing or pending patents will be sufficiently broad or strong to protect our proprietary technology. There is also no guarantee that any patents we hold will not be challenged, invalidated or circumvented, or that the patent rights granted will provide competitive advantages to us. Our competitors have developed and may continue to develop and obtain patents for technologies that are similar or superior to our technologies. In addition, the laws of foreign jurisdictions in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as do the laws of the United States. Adverse outcomes in current or future legal disputes regarding patent and other intellectual property rights could result in the loss of our intellectual property rights, subject us to significant liabilities to third parties, require us to seek licenses from third parties on terms that may not be reasonable or favorable to us, prevent us from manufacturing, importing or selling our products, or compel us to redesign our products to avoid infringing third parties’ intellectual property. As a result, our product offerings may be delayed, and we may be unable to meet customers’ requirements in a timely manner. Regardless of the merit of any related legal proceeding, we have incurred in the past and may be required to incur in the future substantial costs to prosecute, enforce or defend our intellectual property rights. Even in the absence of infringement by our products of third parties’ intellectual property rights, or litigation related to trade secrets, we have elected in the past and may in the future elect to enter into settlements to avoid the costs and risks of protracted litigation and the diversion of resources and management’s attention. However, if the terms of settlements entered into with certain of our competitors are not observed or enforced, we may suffer further costs and risks. Any of these circumstances could have a material adverse effect on our business, financial condition and resources or results of operations. Our ability to develop intellectual property depends in large part on hiring, retaining and motivating highly qualified design and engineering staff with the knowledge and technical competence to advance our technology and productivity goals. To protect our trade secrets and proprietary information, generally we have entered into confidentiality agreements with our employees, as well as with consultants and other parties. If these agreements prove inadequate or are breached, our remedies may not be sufficient to cover our losses. We have recently filed new patent applications for various new products including our J-Plasma™ handpiece. ***Divestitures of some of our operations or product lines may materially and adversely affect our business and results of operations.*** We periodically evaluate the performance of all of operations and we may sell, consolidate, or close a portion of our business or product lines. Any divestitures may result in significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our business and results of operations. Divestitures could involve additional risks, including difficulties in the separation of operations, services, products and personnel, the diversion of management’s attention from other business concerns, the disruption of our business and the potential loss of key employees. During 2010, after evaluating the future outlook of our patent related to our SEER™ product line, we determined that the asset value was impaired and further calculated the impairment loss to be approximately $1.3 million. We may not be successful in managing these or any other significant risks that we encounter in divesting a business or product line. ***We are subject to litigation proceedings that could adversely affect our business.*** #### Intellectual Property Litigation or Trade Secrets We have received certain allegations of infringement of intellectual property rights and use of trade secrets in the past and may receive other such claims, with or without merit, in the future. Previously, claims of infringement of intellectual property rights have sometimes evolved into litigation against us, and they may continue to do so in the future. It is inherently difficult to assess the outcome of litigation and there can be no assurances on us prevailing. Any such litigation could result in substantial cost to us, significantly reduce our cash resources, and create a diversion of the efforts of our technical and management personnel, which could have an adverse effect on our business, financial condition and operating results. If we are unable to successfully defend against such claims, we could be prohibited from future sales of the allegedly infringing product or products, which could materially and adversely affect our future growth. #### Product Liability Litigation Although we carry liability insurance, due to the nature of our products and their use by professionals, we may, from time to time, be subject to litigation from persons who sustain injury during medical procedures in hospitals, physician’s offices or in clinics and defending such litigations is expensive, disruptive, time consuming and could adversely affect our business. Bovie currently maintains product liability insurance with combined coverage limits of $10 million on a claims-made basis. There is no assurance that this coverage will be adequate to protect us from any possible liabilities (individually or in the aggregate) we might incur in connection with the sale or testing of our products. In addition, we may need increased product liability coverage as additional products are commercialized. This insurance is expensive and in the future may not be available on acceptable terms, if at all. #### Other Litigation In addition to the litigation risks and proceedings mentioned above, we are currently involved or may become subject to legal claims or proceedings related to securities, employment, customer or third party contracts, environmental regulations, product liability or other matters. If we are required to defend against a legal claim or deem it necessary or advisable to initiate a legal proceeding to protect our rights, the expense and distraction of such a claim or proceeding, whether or not resolved in our favor, could materially and adversely effect our business, financial condition and operating results. Further, if a claim or proceeding were resolved against us or if we were to settle any such dispute, we could be required to pay damages and costs or refrain from certain activities, which could have a material adverse impact on our business, financial condition and operating results. (see ITEM 3. Legal Proceedings) ***Our business is subject to the potential for defects or failures associated with our products which could lead to recalls or safety alerts and negative publicity.*** Manufacturing flaws, component failures, design defects, off-label uses or inadequate disclosure of product-related information could result in an unsafe condition or the injury or death of a patient. These problems could lead to a recall of, or issuance of a safety alert relating to, our products and result in significant costs and negative publicity. Due to the strong name recognition of our brands, an adverse event involving one of our products could result in reduced market acceptance and demand for all products within that brand, and could harm our reputation and our ability to market our products in the future. In some circumstances, adverse events arising from or associated with the design, manufacture or marketing of our products could result in the suspension or delay of our current regulatory reviews of our applications for new product approvals. We also may undertake voluntarily to recall products or temporarily shut down certain production lines based on internal safety and quality monitoring and testing data. Any of the foregoing problems could disrupt our business and have a material adverse effect on our business, results of operations, financial condition and cash flows. ***We have incurred and may in the future incur impairments to goodwill or long-lived assets.*** We review our long-lived assets, including goodwill and other intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Additionally, if in any period our stock price decreases to the point where our fair value, as determined by our market capitalization, is less than the book value of our assets, this could also indicate a potential impairment and we may be required to record an impairment charge in that period, which would adversely affect our results of operations. Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely heavily on projections of future operating performance. We operate in highly competitive environments and projections of future operating results and cash flows may vary significantly from actual results. Additionally, if our analysis indicates potential impairment to goodwill or any other long-lived intangible asset, we may be required to record additional charges to earnings in our financial statements, which could negatively impact our results of operations. ### Risks Related to Our Industry ***The medical device industry is highly competitive and we may be unable to compete effectively.*** The medical device industry is highly competitive. Many competitors in this industry are well-established, do a substantially greater amount of business, and have greater financial resources and facilities than we do. Domestically, we believe we rank third in the number of units sold in the field of electrosurgical generator manufacturing and we sell our products and compete with other manufacturers in various ways. In addition to advertising, attending trade shows and supporting our distribution channels, we strive to enhance product quality, improve user friendliness and expand product exposure. We also compete by private labeling our products for major distributors under their label. This allows us to increase our position in the marketplace and thereby compete from two different approaches, our Aaron or Bovie® label, and our customers’ private label. Our private label customers distribute our products under their name through their internal sales force. We believe our main competitors do not private label their products. Lastly, at this time we sell the majority of our products through distributors. Many of the companies we compete with sell direct, thus competing directly with distributors they sometimes use. Our main competitors are Valleylab (a division of Covidien), Conmed and Erbe Electromedizine, in the electrosurgery market, Xomed (a division of Medtronics), in the battery operated cautery market, and Ethicon and U.S. Surgical in the endoscopic instrumentation market. We believe our competitive position did not materially change in 2010. ***Our industry is highly regulated by the U.S. Food and Drug Administration and internationally including other governmental, state and federal agencies which have substantial authority to establish criteria which must be complied with in order for us to continue in operation.*** ### United States The Company’s products and research and development activities are subject to regulation by the FDA and other regulatory bodies. FDA regulations govern, among other things, the following activities: - Product development. - Product testing. - Product labeling. - Product storage. - Pre-market clearance or approval. - Advertising and promotion. - Product traceability, and - Product indications. In the United States, medical devices are classified on the basis of control deemed necessary to reasonably ensure the safety and effectiveness of the device. Class I devices are subject to general controls. These controls include registration and listing, labeling, pre-market notification and adherence to the FDA Quality System Regulation. Class II devices are subject to general and special controls. Special controls include performance standards, post market surveillance, patient registries and FDA guidelines. Class III devices are those which must receive pre-market approval by the FDA to ensure their safety and effectiveness. Currently, we only manufacture Class I and Class II devices. Pre-market notification clearance must be obtained for some Class I and most Class II devices when the FDA does not require pre-market approval. All Bovie products have been cleared by the Pre-market notification process. To date, the FDA has not failed to clear any devices we have submitted. A pre-market approval application is required for most Class III devices. A pre-market approval application must be supported by valid scientific evidence to demonstrate the safety and effectiveness of the device. The pre-market approval application typically includes: - Results of bench and laboratory tests, animal studies, and clinical studies - A complete description of the device and its components - A detailed description of the methods, facilities and controls used to manufacture the device, and proposed labeling. The pre-market approval process can be expensive, uncertain and lengthy. A number of devices for which pre-market approval has been sought by other companies have never been approved for marketing. ### International Regulation To market products in the European Union, our products must bear the “CE” mark. Manufacturers of medical devices bearing the CE mark have gone through a conformity assessment process that assures that products are manufactured in compliance with a recognized quality system and to comply with the European Medical Devices Directive. Each device that bears a CE mark has an associated technical file that includes a description of the following: - Description of the device and its components, - A summary of how the device complies with the essential requirements of the medical devices directive, - Safety (risk assessment) and performance of the device, - Clinical evaluations with respect to the device, - Methods, facilities and quality controls used to manufacture the device, and - Proposed labeling for the device. Manufacturing and distribution of a device is subject to ongoing surveillance by the appropriate regulatory body to ensure continued compliance with quality system and reporting requirements. We began CE marking of devices for sale in the European Union in 1999. In addition to the requirement to CE mark, each member country of the European Union maintains the right to impose additional regulatory requirements. Outside of the European Union, regulations vary significantly from country to country. The time required to obtain approval to market products may be longer or shorter than that required in the United States or the European Union. Certain European countries outside of the European Union do recognize and give effect to the CE mark certification. We are permitted to market and sell our products in those countries. ***If we are unable to successfully introduce new products or fail to keep pace with competitive advances in technology, our business, financial condition and results of operations could be adversely affected. In addition, our research and development efforts rely upon investments and alliances, and we cannot guarantee that any previous or future investments or alliances will be successful.*** Our research and development activities are an essential component of our efforts to develop new innovative products for introduction in the marketplace. New and improved products play a critical role in our sales growth. We continue to place emphasis on the development of proprietary products and product improvements to complement and expand our existing product lines. We maintain close working relationships with physicians and medical personnel in hospitals and universities who assist in product research and areas of development. Our research and development activities are primarily conducted internally and are expensed as incurred. These expenses include direct expenses for wages, materials and services associated with the development of our products net of any reimbursements from customers. Research and development expenses do not include any portion of general and administrative expenses. Our Clearwater, Florida facility has been our flagship research and design location. We expect to continue making future investments to enable us to develop new technologies and products to further our strategic objectives and strengthen our existing business. However, we cannot guarantee that any of our previous or future investments will be successful. The amount expended by us on research and development of our products during the years 2010, 2009 and 2008, totaled approximately $1.9, $2.1, and $2.1 million respectively. During the past three years, we invested in our J-Plasma™ technology, currently used in one of our new products under development, the ICON™ GS plasma system. In addition, we invested in the BOSS™ and other saline-enhanced electrosurgical devices, Endoscopic Modular Instruments, and accompanying new generators. We have not incurred any direct costs relating to environmental regulations or requirements. For 2011, we expect the amount of our expenditures for research and development activities to remain around the same level as 2010. ***Even if we are successful in developing and obtaining approval for our new product candidates, there are various circumstances that could prevent the successful commercialization of the products.*** Our ability to successfully commercialize our products will depend on a number of factors, any of which could delay or prevent commercialization, including: - the regulatory approvals of our new products are delayed or we are required to conduct further research and development of our products prior to receiving regulatory approval; - we are unable to build a sales and marketing group to successfully launch and sell our new products; - we are unable to raise the additional funds needed to successfully develop and commercialize our products or acquire additional products for growth; - we are required to allocate available funds to litigation matters; - we are unable to manufacture the quantity of product needed in accordance with current good manufacturing practices to meet market demand, or at all; - our product is determined to be ineffective or unsafe following approval and is removed from the market or we are required to perform additional research and development to further prove the safety and effectiveness of the product before re-entry into the market; - competition from other products or technologies prevents or reduces market acceptance of our products; - we do not have and cannot obtain the intellectual property rights needed to manufacture or market our products without infringing on another company’s patents; or - we are unsuccessful in defending against patent infringement or other intellectual property rights, claims that could be brought against us, our products or technologies; The failure to successfully acquire or develop and commercialize new products will adversely affect the future growth of our business, financial condition and results of operations. ***Our international operations subject us to foreign currency fluctuations and other risks associated with operating in foreign countries.*** We operate internationally and enter into transactions denominated in foreign currencies. To date, we have not hedged our exposure to changes in foreign currency exchange rates, and as a result, we are subject to foreign currency transaction and translation gains and losses. We purchase goods and services in U.S. dollars and Euros. Foreign exchange risk is managed primarily by satisfying foreign denominated expenditures with cash flows or assets denominated in the same currency. Our currency value fluctuations were not material for 2010. ***Our operations and cash flows may be adversely impacted by the recently passed healthcare reform legislation.*** The Patient Protection and Affordable Care Act and Health Care and Education Affordability Reconciliation Act were enacted into law in the U.S. in March 2010. Since 80% of our 2010 sales were derived in the U.S., this legislation will materially impact us. Among other initiatives, this legislation imposes a 2.3% excise tax on domestic sales of class I, II, and III medical devices beginning in 2013. Substantially all of our products are class I or class II medical devices. If we are unable to raise prices or otherwise pass through this tax to our customers, this enacted excise tax on medical devices could materially and adversely affect our results of operations and cash flows. Further, we cannot predict if any additional regulations will be implemented at the federal or state level, or the effect of any future legislation or regulation in the U.S. or internationally. ***Our operations may experience higher costs to produce our products as a result of changes in prices for oil, gas and other commodities.*** We use some plastics and other petroleum-based materials along with precious metals contained in electronic components as raw materials in many of our products. Prices of oil and gas also significantly affect our costs for freight and utilities. Oil, gas and precious metal prices are volatile and may increase, resulting in higher costs to produce and distribute our products. Due to the highly competitive nature of the healthcare industry and the cost-containment efforts of our customers we may be unable to pass along cost increases through higher prices. If we are unable to fully recover these costs through price increases or offset through other cost reductions, our results of operations could be materially and adversely affected. ***Our manufacturing facilities are located in Clearwater, Florida and could be affected due to multiple risks from fire, hurricanes, physical changes in the planet due to climate change, and the like*** Our manufacturing facilities are located in Clearwater, Florida and could be affected by multiple weather risks, most notably hurricanes, one of which previously caused damage to the roof of one of our buildings as well as some of our furniture and equipment. The damage was mildly disruptive to operations. Although we carry property and casualty insurance and business interruption insurance, future possible disruptions of operations or damage to property, plant and equipment due to hurricanes or other weather risks could result in impaired production and affect our ability to meet our commitments to our customers and impair important business relationships, the loss of which could adversely affect our operations and profitability. We do however maintain a backup generator at our Clearwater facility and a disaster recovery plan is in place to help mitigate this risk. We do not produce hazardous materials or emissions that would adversely impact the environment. We do however, have air conditioning units and consume electricity which could be impacted by climate change in the form of increased rates. We do not however believe the increase in expense from the rate increases, as a percentage of sales, would be material in the near term. **Risks related to global natural disasters (whether or not caused by climate change), unusual weather conditions, pandemic outbreaks, terrorist acts, and global political events** The occurrence of one or more natural disasters, such as hurricanes, tsunamis, fires, floods, and earthquakes (whether or not caused by climate change), unusual weather conditions, pandemic outbreaks, terrorist acts or disruptive global political events, such as civil unrest in countries in which our suppliers are located, or similar disruptions could impair our ability to purchase, receive, or replenish inventory which could result in lost sales and otherwise adversely and materially affect our operations and financial performance. These events also can have indirect consequences such as increases in fuel (or other energy) prices or a fuel shortage, or increases in the costs of insurance if they result in significant loss of property or other insurable damage. ### Risks Related to Our Stock ### The market price of our stock has been and may continue to be highly volatile. Our common stock is listed on the NYSE Amex Market under the ticker symbol “BVX.” The market price of our stock has been and may continue to be highly volatile, and announcements by us or by third parties may have a significant impact on our stock price. These announcements may include: - our listing status on the NYSE Amex Market; - our operating results or operating results below the expectations of public market analysts and investors; - developments in our relationships with or developments affecting our major customers; - negative regulatory action or regulatory non-approval with respect to our new products; - government regulation, governmental investigations, or audits related to us or to our products; - developments related to our patents or other proprietary rights or those of our competitors; and - changes in the position of securities analysts with respect to our stock; The stock market has from time to time experienced extreme price and volume fluctuations, which have particularly affected the market prices for the medical technology sector companies, and which have often been unrelated to their operating performance. These broad market fluctuations may adversely affect the market price of our common stock. Historically, when the market price of a stock has been volatile, holders of that stock have often instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. The lawsuit could also divert the time and attention of our management. In addition, future sales by existing stockholders or any new stockholders receiving our shares in any financing transaction may lower the price of our common stock, which could result in losses to our stockholders. Future sales of substantial amounts of common stock in the public market, or the possibility of such sales occurring, could adversely affect prevailing market prices for our common stock or our future ability to raise capital through an offering of equity securities. Substantially all of our common stock is freely tradable in the public market without restriction under the Securities Act, unless these shares are held by our “affiliates”, as that term is defined in Rule 144 under the Securities Act. ***Exercise of warrants and options issued by us will dilute the ownership interest of existing stockholders.*** As of December 31, 2010, the warrants issued by us in April 2010 were exercisable for up to approximately 339,000 shares of our common stock, representing approximately 2% of our then outstanding common stock. As of December 31, 2010, our outstanding stock options to our employees, officers, directors and consultants were exercisable for up to 1.9 million shares of our common stock, representing approximately an additional 11% of our then outstanding common stock. The exercise of some or all of our warrants and stock options will dilute the ownership interests of existing stockholders. Any sales in the public market of the common stock issuable upon such conversion or exercise could adversely affect prevailing market prices of our common stock. ## Properties As filed, 1,134 characters. Bovie currently maintains the following locations: - Our executive office at 734 Walt Whitman Road, Melville, New York, which is leased for approximately $1,500 per month. - A 60,000 square foot facility which consists of office, warehousing, manufacturing and research space located at 5115 Ulmerton Rd., Clearwater, Florida Monthly principal and interest payments are approximately $24,000 per month. - A research and manufacturing facility at 3200 Tyrone Blvd., St. Petersburg, Florida which is leased for approximately $13,000 per month under a lease that expires in October 2013. - A separate warehouse facility in Clearwater, Florida that we lease for approximately $1,600 per month. During 2010, we sold our facility located at 7100 30th Ave. N., St. Petersburg, Florida for net proceeds of approximately $633,000, which resulted in a loss on the sale from our book value of approximately $300,000. We still have a sublease listing with a broker for the leased facility at 3200 Tyrone Blvd., St. Petersburg, Florida. In 2010 we closed our Windsor, Canada facility and moved the operations to our Clearwater, Florida facility. ## Legal proceedings As filed, 5,129 characters. On June 10, 2010, we received notice that an action had been commenced against us in the United States Court for the District of Delaware (Civil Action No. 1:10-cv-00494-UNA) by Salient Surgical Technologies, Inc. and Medtronic, Inc. (the “Plaintiffs”). In the complaint, the Plaintiffs alleged that the sale and use of our SEER™ (Saline Enhanced Electrosurgical Resection) fluid-assisted electrosurgical devices infringed on an issued United States patent presently owned by Medtronic and licensed to Salient. The Plaintiffs were demanding a permanent injunction restraining us, and our affiliates, and any person acting in privity or in concert or participation with us from the continued infringement of the patent as well as unspecified monetary damages. Subsequently, on March 3, 2011 we signed a settlement agreement related to the above-mentioned action with Salient Surgical Technologies, Inc. and Medtronic, Inc. The settlement calls for us and related parties to immediately exit and not enter into the monopolar and bipolar saline-enhanced RF device business (including SEER™ and BOSS™) worldwide through February 2015. In exchange, the Plaintiffs made a one-time payment to us of $750,000. As a condition we will not be able to sell certain finished products, which as of the settlement date amounted to approximately $100,000 of our inventory. Therefore we will be required to determine whether a valuation reserve will be required in the first quarter of 2011. The terms also include a provision outlining a possible OEM contract manufacturing relationship between Salient and our Company. We currently already have a longstanding OEM contract manufacturing agreement with Medtronic for advanced electrosurgical generators.. On July 9, 2010, we filed a complaint in the United States District for the Middle District of Florida (Tampa division) naming Steven Livneh, who at the time was a director of the Company, and two of his related entities as defendants. In our complaint, we are seeking, among other things, a declaratory judgment from the Court concerning our rights under certain agreements entered into with the defendants in 2006 in connection with our acquisition of certain assets and technology, including intellectual property relating to our Seal-N-Cut™ product. We are also seeking damages for breach of contract, breach of fiduciary duty by Mr. Livneh relating to his service as an officer and director of the Company, tortious interference with contractual relations, defamation, slander of title and injunctive relief. Mr. Livneh filed a motion seeking to (a) dismiss the complaint or, in the alternative, to (b) transfer venue. On December 20, 2010 the court issued an order dismissing without prejudice five of our fifteen claims, due to New York being defined in the forum selection clauses in two of the underlying contracts with Mr. Livneh. The Company re-filed these five claims in federal court in New York. Mr. Livneh’s motion to dismiss the remaining claims in Florida was denied and the venue was not transferred. Subsequently, on January 10, 2011 defendant Livneh filed a counter-complaint/third party complaint against us, our CEO, and our COO, alleging fraud, fraud in the inducement, fraudulent misrepresentation, breach of fiduciary duty, negligent misrepresentation, innocent misrepresentation, breach of contract, tortuous interference, shareholder derivative, defamation, breach of good faith and fair dealing, violation of the Uniform Trade Secrets Act, and violation of the Florida Whistleblower’s Act, and seeking recission and a declaratory judgment. In addition to the foregoing relief, Defendant also seeks reinstatement of Mr. Livneh to the Company’s board of directors, issuance of certain shares of unrestricted stock, compensatory, actual and/or special damages, punitive and/or exemplary damages, and attorney’s fees and costs. The range of loss is not estimable at this time. On December 3, 2010, Dr. David Eisenstein, MD filed a complaint and demand for jury trial against us, alleging breach of contract, quantum meruit, and promissory estoppel. Dr. Eisenstein is seeking actual damages, consequential damages, incidental damages, pre-filing and post filing interest, and attorney fees and costs. We believe we have meritorious defenses to these claims, and we intend to vigorously defend this litigation. It is too early in the proceeding to determine the extent, if any, of our possible exposure in the lawsuit. As such, no effect has been given herein to any loss that may result from the resolution of this matter in the accompanying consolidated financial statements. In the normal course of business, we are subject, from time to time, to legal proceedings, lawsuits and claims. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. Consequently, we are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters as of December 31, 2010. These matters could affect the operating results of any one or more quarter when resolved in future periods. ## Management's discussion and analysis As filed, 39,444 characters. You should read the following discussion and analysis in conjunction with our financial statements and related notes contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors discussed in this report and those discussed in other documents we file with the SEC. In light of these risks, uncertainties and assumptions, readers are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements represent beliefs and assumptions as of the date of this report. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. ### Executive Level Overview We are a medical device company engaged in the manufacturing and marketing of electrosurgical devices. Our medical products include a wide range of devices including electrosurgical generators and accessories, cauteries, medical lighting, nerve locators and other products. We internally divide our operations into three product lines. Electrosurgical products, battery-operated cauteries and other products. The electrosurgical line sells electrosurgical products which include desiccators, generators, electrodes, electrosurgical pencils and various ancillary disposable products. These products are used in surgery for the cutting and coagulation of tissue. Battery-operated cauteries are used for precise hemostasis (to stop bleeding) in ophthalmology and in other fields. Our other revenues are derived from nerve locators, disposable and reusable penlights, medical lighting, license fees, development fees and other miscellaneous income. Most of the Company’s products currently are marketed through medical distributors, which distribute to more than 6,000 hospitals, and to doctors and other health-care facilities. New distributors are contacted through responses to our advertising in international and domestic medical journals and domestic or international trade shows. International sales represented 21% of total revenues in 2010 as compared with 16% in 2009 and 17% in 2008. The Company’s products are sold in more than 150 countries through local dealers which are coordinated by sales and marketing personnel at the Clearwater, Florida facility. As mentioned previously for the launch of our new surgical suite product lines, we have established the use of a network of approximately 50 commission-based independent direct sales contractors to market these products. Our business is generally not seasonal in nature. ### Outlook for 2011 The Company continues to place great effort and resources into the development of J-Plasma recently submitting to the FDA a new handpiece with retractable cutting features used in both laparoscopic and open procedures. Since the outset of the current fiscal year, surgeons operating in diverse specialties have been engaged in evaluating J-Plasma and the feedback received is most encouraging. Increased emphasis has been placed on sales and marketing with the hiring of new personnel and the engagement of over 50 independent sales representatives. We have been pleased with the sales of Bovie’s Resistick™ II coated blades and the initial orders of our laparoscopic instruments through this network. Finally, accelerated progress has been achieved in the development of our vessel sealing instrument line since moving its operations from Canada to our headquarters in Clearwater, FL. We anticipate resubmitting a 510k application in the second half of 2011. There is much uncertainty in today’s economic climate; however, we have made every effort to base our outlook and business strategy on a conservative approach and one based on knowledge and experience. In today’s economic environment, marked by historic uncertainty, forecasting has become increasingly more difficult. We have and will always, take a conservative approach. Every effort has been made to provide an outlook based on our experience and knowledge; however, variations beyond our ability to predict or control often impact forecasting which may result in a change in this outlook. We strongly encourage investors to visit our website: www.boviemedical.com to view the most current news and to review our filings with the Securities and Exchange Commission. ### Results of Operations – #### Sales | Sales by Product Line (in thousands) | 2010 vs. 2009 2010 | 2009 | Percent change | 2009 vs. 2008 2009 | 2008 | Percent change | | --- | ---: | ---: | ---: | ---: | ---: | ---: | | Electrosurgical | $15,956 | 18,576 | (14.1)% | $18,576 | 19,535 | (4.9)% | | Cauteries | 6,383 | 6,252 | 2.1% | 6,252 | 6,265 | (0.2)% | | Other | 1,891 | 2,125 | (11.0)% | 2,125 | 2,296 | (7.5)% | | Total | $24,230 | 26,953 | (10.1)% | $26,953 | 28,096 | (4.1)% | | Sales by Domestic and International (in thousands) | | | | | | | | Domestic | $19,174 | 22,506 | (14.8)% | $22,506 | 23,176 | (2.9)% | | International | 5,056 | 4,447 | 13.7% | 4,447 | 4,920 | (9.6)% | | Total | $24,230 | 26,953 | (10.1)% | $26,953 | 28,096 | (4.1)% | Sales for the year ended December 31, 2010 decreased approximately $2.7 million or 10.1% compared to the same period in 2009. This overall decrease was due to the following reasons: - sales of electrosurgical disposables decreased approximately $3.6 million or 14.1% mainly due to the reduction in sales of Arthrex ablators offset by an increase in sales of electrodes; and - sales of other products were down approximately $234,000 or 11.0% mainly due to a reduction in the sale of penlights. Some partial offsets to this decrease in sales for the year ended December 31, 2010, compared to the same period in 2009 were: - domestic and international sales of electrosurgical generators increased by approximately $1.0 million or 8.7% due to increased demand; and - cautery sales were up approximately $131,000 or 2.1% mainly as a result of an increase in replaceable cauteries demand. Sales for the year ended December 31, 2009 decreased approximately $1.1 million or 4.1% compared to the same period in 2008. This decrease was due to the following reasons: - sales of generators were down approximately $930,000 or 7.2% due to lower capital expenditures by hospitals and doctor offices in the current economy; - sales of other products were down approximately $170,000 or 7.5%. This consisted of a $41,000 reduction in royalty income due to royalty contracts ending in 2008; a $50,000 reduction in the sales of penlights; $74,000 reduction in medical lighting sales; and a $5,000 reduction in miscellaneous other products. These decreases are mainly the result of distributors electing to reduce their inventories in the current economy. Our ten largest customers accounted for approximately 66.5%, 71.5%, and 70% of net revenues for 2010, 2009, and 2008 respectively. In 2010, 2009 and 2008, Arthrex accounted for over 10% of total revenues (11%, 22%, and 20% of our revenues for each such year). In 2010, National Distribution & Contracting Inc. also accounted for 11% of the sales. Sales of generators and accessories to Arthrex decreased by approximately $3.2 million or 53.3% to approximately $2.8 million for the year ended December 31, 2010 from approximately $6.0 million for the year ended December 31, 2009. Conversely, sales of generators and accessories to Arthrex increased by approximately $245,000, or 4.3% to approximately $6.0 million for the year ended December 31, 2009 from approximately $5.7 million for the year ended December 31, 2008. #### Gross Profit *(in thousands)* | | Years ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs 09’ | | --- | ---: | ---: | ---: | ---: | ---: | | Cost of sales | $14,242 | $15,099 | (5.7%) | $16,248 | (7.1)% | | Cost of sales as a percentage of revenue | 58.8% | 56.0% | | 57.8% | | | Gross profit | $9,988 | $11,855 | (15.7%) | $11,849 | 0.1% | | Gross profit as a percentage of revenue | 41.2% | 44.0% | (2.8%) | 42.2% | 1.8% | Overall gross profit dollars declined by approximately $1.9 million, or a decrease of 15.7%, in the year ended December 31, 2010 compared to the same period for 2009 primarily the result of: - a $2.7 million decline in overall sales; and - a 2.8% increase in cost of sales as a percentage of sales which was primarily driven by product mix material costs. In 2010 we experienced a reduction in sales of ablators (a higher margin product) coupled with an increase in sales of generators (lower margin product) and electrodes, and as a result our gross profit as a percentage of sales was approximately 41.2% for the year ended December 31, 2010 compared to 44.0% for the same period for 2009, a decrease of 2.8%; Overall cost of sales dollars declined by approximately $857,000 as a result of: - approximately $1.35 million reduction of material cost associated with the reduced sales; - offset by an approximate $365,000 decrease in capitalized manufacturing overhead which has the effect of increasing expenses; - offset by an additional increase in direct and indirect labor costs amounting to approximately $30,000; and - offset by a $98,000 increase in component costs which were previously manufactured and purchased from our former Canadian subsidiary at a lower cost. In relation to the $1.1 million decline in sales, the 1.8% increase in gross profit as a percentage of sales in the year ended December 31, 2009 compared to the same period for 2008 was primarily a result of: - an approximate $308,000 increase in capitalized manufacturing overhead; - an approximate $105,000 reduction in annual bonuses; - an approximate $108,000 reduction of our company match to our employees’ 401(k) contributions; - an additional decrease in direct and indirect labor costs amounting to approximately $101,000; and - an approximate $476,000 reduction in direct material cost as a result of the $1.1 million reduction in sales. We do not anticipate any material impact to our gross profit, material costs, or other costs as a result of the effect of inflation or changing prices on net revenue. #### Gain on Cancellation of Agreement *(in thousands)* | | Year ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs.09 | | --- | ---: | ---: | ---: | ---: | ---: | | Gain on cancellation of agreement | -- | -- | -- | $1,496 | -- | | Gain as a percentage of revenue | -- | -- | -- | 5.3% | -- | During the year ended December 31, 2008, we recognized a one-time gain from a cancellation of a contract with Boston Scientific Corporation of approximately $1.5 million. We had no such activity in 2010 or 2009. For an explanation of this gain, please see Note 15 in our consolidated financial statements. #### Research and development *(in thousands)* | | Year ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs.09’ | | --- | ---: | ---: | ---: | ---: | ---: | | Research and Development expense | $1,854 | $2,083 | (11.0%) | $2,061 | 1.1% | | R&D expense as a percentage of revenue | 7.7% | 7.7% | | 7.3% | | Our R&D expense dollars decreased by approximately $229,000 or 11% in the year ended December 31, 2010 as compared to the same period for 2009, but as a percentage of sales it remained the same year over year. The decrease in dollars was primarily the result of: - an increase in engineering costs of approximately $72,000 related to continued development of the new product lines; - increases in consulting fees of approximately $85,000 related to the development of our vessel sealing product - an increase in costs of approximately $78,000 related to the end stage development of the Plasma product line. These increases were offset by: - a decrease in R&D costs for the labor force and other overhead costs related to our Canadian facility in the amount of approximately $464,000. The 1.1% increase in R&D expenses in the year ended December 31, 2009 compared to the same period for 2008 was primarily a result of: - increased costs of approximately $120,000 related to continued development of the BOSS™ and other related sintered steel product line; - increase in costs of approximately $22,000 related to the end stage development of the ICON™ GS (J-Plasma™). These increases were offset by: - a decrease in R&D costs for the labor force and other overhead costs related to our Canadian facility in the amount of approximately $120,000. #### Professional services *(in thousands)* | | Year ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs.09’ | | --- | ---: | ---: | ---: | ---: | ---: | | Professional services expense | $1,556 | $1,398 | 11.3% | $991 | 41.1% | | Professional services as a percentage of revenue | 6.4% | 5.2% | | 3.5% | | The 11.3% or approximately $158,000 increase in professional services costs in the year ended December 31, 2010 compared to the same period for 2009 was primarily the result of: - increased consulting fees related to engaging a consulting firm to support marketing of new products of approximately $49,000; - higher legal fees related to the Salient/Medtronics and Livneh lawsuits compared to the fees incurred for the Erbe lawsuit in 2009 by approximately $80,000; and - increased tax consulting costs of $65,000 which were related to an IRS audit being conducted during the latter half of 2010. These increases were offset by: - A decrease of approximately $36,000 in legal fees attributable to patent costs incurred by our Canadian facility for the Seal-N-Cut™ and other developing products. The 41.1% increase in professional services costs in the year ended December 31, 2009 compared to the same period for 2008 was primarily a result of: - increased legal fees related to the Erbe lawsuit of approximately $339,000; - increased legal fees related to Security and Exchange Commission filings and correspondence of approximately $57,000; and - increased audit and accounting costs of $51,000 related to additional tax-related issues and Sarbanes-Oxley compliance and related testing. These increases were offset by: - A decrease of approximately $30,000 in legal fees attributable to patent costs incurred by our Canadian facility for the Seal-N-Cut™ and other developing products. #### Salaries and related costs *(in thousands)* | | Year ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs.09’ | | --- | ---: | ---: | ---: | ---: | ---: | | Salaries and related expenses | $3,155 | $3,003 | 5.1% | $3,016 | (0.5)% | | Salaries & related expenses as a percentage of revenue | 13.0% | 11.1% | | 10.7% | | Our salaries and related cost dollars increased by approximately $152,000, or 5.1% for the year ended December 31, 2010 when compared to the same period in 2009. Salaries and related cost as a percentage of sales increased by approximately 1.9% for the year ended December 31, 2010 when compared to the same period in 2009. The increase was primarily the result of the following: - a $230,000 increase in salaries due to new legal counsel, which includes a onetime $80,000 salary payment to cover relocation and housing costs; - a $32,000 increase in health insurance cost; - a $36,000 increase in compensation expense due to the issuance of new options; and - a $19,000 increase in employee benefits. The increase in salaries and related cost for the year ending December 31, 2010 as compared to the same period in 2009 was partially offset by: - a $145,000 decrease in marketing salaries from a net elimination of one high-level marketing position during the year; - a $20,000 decrease in salaries for Bovie Canada due to the consolidation of those operations to our Florida facility. The 0.5% decrease in salaries and related costs in the year ended December 31, 2009 compared to the same period for 2008 was primarily a result of: - management’s cost cutting plan implemented in 2009 which resulted in a decrease of approximately $94,000 related to the suspension of employee bonuses, salary increases, and vacation cash out ability. In addition, we had a decrease of approximately $52,000 related to the suspension of the company’s 401(k) match; - a decrease in the administrative labor force located at our Canadian facility amounting to approximately $18,000; - a reduction in the amount of employee stock option expense booked in the amount of approximately $29,000; and - a reduction in other employee benefits by approximately $31,000. These decreases were offset by: - adding additional sales force employees related to our SEER™ and MEG™ product lines of approximately $179,000; and - an increase in employee health insurance costs of approximately $32,000. #### Selling, general and administrative expenses *(in thousands)* | | Year ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs.09’ | | --- | ---: | ---: | ---: | ---: | ---: | | SG&A expense | $4,889 | $4,656 | 5.0% | $4,489 | 3.7% | | SG&A expense as a percentage of revenue | 20.2% | 17.3% | | 16.0% | | | Loss on impairment of IP | $1,286 | -- | | -- | | | | 5.3% | | | | | The 5.0% increase in selling, general and administrative costs of approximately $233,000 for the year ended December 31, 2010 as compared to the same period in 2009 was primarily the result of the following: - a $327,000 loss on disposition of assets from the sale of the St Petersburg Florida property and some of the Canadian assets; - a $25,000 increase in consulting costs for the development of our surgical suite marketing plan; - a $78,000 increase in advertising costs and marketing supplies to support our distribution and new product sales; - a $85,000 increase in regulatory costs to support our new products; - a $30,000 increase in travel costs as a result of travel to support the development and sale of new products; - a $95,000 increase in show costs to support new product sales ; - a $33,000 increase in foreign currency loss due to fluctuation in rates attributable to vendor payments and the consolidation of our Canadian operations to Florida; - a $35,000 increase in credit card and bank fees as more customers are paying by credit card; - a $23,000 increase in promotional training for our distribution and new government contract sales; - a $32,000 increase in repair and maintenance due to supporting a larger facility; and - a $20,000 increase in computer and infrastructure costs. The increase in salaries and related cost for the year ended December 31, 2010 as compared to the same period in 2009 was offset by: - a $160,000 decrease costs related to a lawsuit settlement in 2009; - a $77,000 decrease in general insurance expense due to an decrease in insurance costs and by a credit from an insurance audit; - a $14,000 reduction in moving costs due to the move to the new facility in 2009 costing more than the move to consolidate our Canadian operations to Florida; - a $98,000 decrease in consulting costs related to our European sales distribution channel; - a $82,000 decrease in depreciation expense attributable to the consolidation of our Canadian operations to Florida; - a $98,000 decrease in utility expense attributable to finalizing the consolidation of our operations in Florida; and - a $21,000 decrease in obsolete inventory provision. The 3.7% increase in selling, general and administration costs in the year ended December 31, 2009 compared to the same period for 2008 was primarily a result of: - a one-time cost for the legal settlement paid to Erbe in the amount of approximately $160,000; - increases in real estate and franchise taxes which amounted to approximately $73,000; - a one-time cost incurred for moving expenses related to the consolidation of our manufacturing to our new facility in the amount of approximately $58,000; - an increase in utilities expense of approximately $89,000 mainly due to the addition of our new facility coupled with power and water company rate increases; - one-time cost related to the installation, transferring, and expansion of a new leased phone and communication system in our new facility which amounted to approximately $47,000; - an increase of approximately $84,000 in amortization expense for new products that went into production in 2009; - an increase in depreciation expense of approximately $36,000, most of which was attributable to our Canadian facility; - a 2009 accrual for the initial minimum royalty expense to be paid on the MEG™ product line which amounted to approximately $19,000; - an increase in general insurance premiums of approximately $40,000; - an increase in our bad debt reserve of approximately $15,000; and - an increase in our stock exchange fees and expenses of approximately $18,000; These increases were offset by: - a decrease in advertising costs in the amount of approximately $97,000; - management’s consolidating of trade show and travel expenses which resulted in a decrease of approximately $275,000; - sales and marketing consulting costs decreased by approximately $77,000 from management re-negotiating the terms of the agreement at the renewal; and - a decrease in regulatory expenses of approximately $23,000. #### Loss on Impairment of Intellectual Property In December 2010, after evaluating the future outlook of our patent related to our SEER™ product line, we determined that the asset value was impaired and further calculated the impairment loss to be approximately $1.3 million. Subsequent to our assessment that the patent was impaired, as a condition of the March 3, 2011 settlement with Salient surgical Technologies, Inc. and Medtronic, Inc., we are required to immediately exit and not enter into the monopolar and bipolar saline-enhanced RF device business (including SEER™ and BOSS™) worldwide through February 2015 (see item 3. Legal Proceedings). As a condition we will not be able to sell certain finished products, which as of the settlement date amounted to approximately $100,000 of our inventory. Therefore we will be required to determine whether a valuation reserve will be required in the first quarter of 2011. The terms of this settlement also included provisions outlining a possible OEM contract manufacturing relationship between Salient and our Company, subject to requisite due diligence. #### Other Income *(in thousands)* | | Year ended December 31, 2010 | 2009 | Percent change 09’vs 10’ | 2008 | Percent change 08’vs.09’ | | --- | ---: | ---: | ---: | ---: | ---: | | Interest income | $15 | $24 | (37.5%) | $49 | (51.0)% | | Interest expense | $(238) | $(76) | 213% | $(59) | 28.8% | | Total other income (expense) | $(223) | $(52) | 329% | $(10) | 420% | | Other income (expense) as a percentage of revenue | (0.9%) | (0.2)% | | (0.0)% | | | Change in fair value of liabilities, net | $513 | $-- | | $-- | 0.0% | | Other Gain as a percentage of sales | 2.1% | 0.0% | | 0.0% | 0.0% | Net interest expense increased by approximately $171,000 or 329% for the year end 2010 as compared to the same period in 2009 primarily due to the capitalization in 2009 of certain interest expenses related to the industrial revenue bonds used to finance our new facility. The change in fair value of liabilities were related to the warrants associated with our equity issuance in April of 2010 and adjustment for the fair value of the Lican liability. The derivative warrant liability was valued at approximately $799,000 at the issuance date and was valued at approximately $332,000 at December 31, 2010 resulting in a year-to-date gain of approximately $467,000. The Lican liability fair value as of December 31, 2009 was $218,150 and was valued at approximately $172,200 at December 31, 2010 resulting in a gain for 2010 of approximately $46,000. Interest income decreased by approximately $9,000 during the year ended December 31, 2010 when compared with 2009, and decreased by approximately $25,000 during the year ended December 31, 2009 when compared with 2008. This was due to lower interest rates on our sweep account coupled with lower cash balances year over year. Interest expense increased progressively from 2008 through 2010 mainly as a direct result of interest incurred on debt originated in 2008. This debt was used to primarily acquire and renovate our new facility and for working capital purposes. The interest expense going forward should be similar to the amount incurred in 2010. ### Income Taxes Our income tax benefit for the year ended December 31, 2010 was approximately $934,000 compared with approximately $67,000 for the year ended December 31, 2009. Our effective tax rate was approximately 37.7% for the years ended December 31, 2010 and 2009, respectively, which is less than our statutory rates because of the deductibility of stock-based compensation and certain research and development tax credits we used during the year. | 2010 | | 2009 | 2008 | | --- | ---: | ---: | ---: | | Federal tax provision% | 34.0 | 34.0 | 34.0 | | State taxes (net of federal benefit) | 4.3 | 2.6 | 5.8 | | Stock based compensation \* | .5 | (15.9) | - | | Research and development credits \* | 5.0 | (12.8) | (2.6) | | Other | (6.1) | 2.3 | (3.2) | | % | 37.7 | 10.2 | 34.0 | \* During 2010, our 2008 and 2009 federal tax returns were selected for examination by the United States Internal Revenue Service (“the IRS”). The exam was concluded in March, 2011. As a result of the IRS exam, our federal net operating loss carryforward was reduced by approximately $350,000 and R&D credits were reduced by approximately $55,000. ### Liquidity and Capital Resources Our working capital at December 31, 2010 was $12.8 million compared with $10.7 million at December 31, 2009. Accounts receivable days sales outstanding were 36 days and 39 days at December 31, 2010 and 2009, respectively. The number of days worth of sales in inventory, which is the total inventory available for production divided by the 12-month average cost of materials, increased 18 days to 212 days equating to an inventory turn ratio of 1.3 at December 31, 2010 from 194 days and an inventory turn ratio of 1.7 at December 31, 2009. The higher number of days worth of sales in inventory which translated into a lower inventory turnover rate is mainly due to the decrease in sales related to our generator product lines which contain a greater number of component parts compared to all our other products. In fiscal 2010, net cash used by operating activities amounted to approximately $566,000 compared with net cash used of approximately $98,000 from operations in 2009. The decrease in cash generated by operations in 2010 compared with the prior year is primarily due to increased costs related to litigation and IRS audit representation, along with increased balances in our inventory due to less sales in 2010. Net cash provided in investing activities was approximately $432,000 for fiscal 2010 compared with a net cash used in investing activities of $2.5 million during 2009. The increase in cash generated by investing activities was due mainly to proceeds received in 2010 from the sale of our St. Petersburg Florida facility, which were in excess of the approximate $201,000 used for the purchase of property and equipment as compared to cash used during fiscal 2009 for purchases amounting to approximately $2.2 million related to amounts expended to refurbish our new Clearwater, Florida facility in the first half of 2009. We generated cash from financing activities of approximately $1.7 million during fiscal 2010, a decrease of approximately $436,000 compared with the same period in 2009. The net decrease in cash from financing activities resulted from the following: - a decline in proceeds from the escrow account of approximately $36,000; - an increase in cash resulting from sales of our common shares of approximately $2.7 million net of placement costs; - a decrease of approximately $0.1 million in proceeds from the exercise of stock options; and - a net decrease in the borrowings of the line of credit of approximately $1 million. We currently have approximately $3.7 million borrowed under industrial revenue bonds which we previously used for the purchase and renovation of our Clearwater, Florida facility through RBC Bank. The bonds, which are being amortized over a 20-year term, balloon in 10 years and bear interest at a fixed interest rate of 4.6%. Scheduled maturities of this indebtedness are $140,000, $145,000, $155,000, $160,000 and $165,000 for 2011, 2012, 2013, 2014 and 2015, respectively. We had approximately $3.8 million in cash and cash equivalents at December 31, 2010. We believe our cash on hand, as well as anticipated cash flows from operations, will be sufficient to meet our operating cash commitments for the next year. Should additional funds be required, we have secured additional borrowing capacity with RBC Bank (USA). (See below) We have an $8 million secured revolving line of credit facility with RBC Bank (USA), which at December 31, 2010 had a zero balance. Advances under the $8 million line of credit are due on demand and bear interest at a rate of LIBOR plus 2% with a minimum floor rate of 4.0% and are secured by a perfected first security interest in our inventory and accounts receivable. In addition we have a separate additional credit facility with RBC Bank (USA) for up to $1 million specific to financing new equipment purchases. This credit facility provides for a 2 year draw up period followed by a 5-year term period and bears interest also at LIBOR plus 2% with a minimum floor of 4% and is secured by a perfected first security interest in the new equipment purchased. We also have the option of financing purchased equipment at 75% of the cost through either a traditional loan or through RBC leasing at the time of purchase. Subsequent available borrowings for both these credit facilities is subject to a borrowing base utilizing a percentage of eligible receivables, inventories, and any assigned cash along with certain financial ratios, specifically maintaining: a ratio of debt to tangible net worth of less than 2.0 to 1.0, a ratio of total funded debt to EBITDA of less than 3.25 to 1.0 excluding the industrial revenue bond note balance which had an original principal amount of $4.0 million, and a ratio of minimum debt service coverage of 1.5 to 1.0 measured on a rolling four quarter basis. At December 31, 2010 we were in full compliance with the loan covenants and ratios of both the credit facilities. According to our most recent borrowing base calculation, we had approximately $4.0 million total availability under the $8 million credit line, of which we currently have a zero balance. We also have available approximately $890,000 under the equipment line of credit. Our future contractual obligations for agreements with initial terms greater than one year and agreements to purchase materials in the normal course of business are summarized as follows (in thousands): | Description | Years Ending December 31, 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | | --- | ---: | ---: | ---: | ---: | ---: | ---: | | Operating leases | $256 | $251 | $227 | $12 | - | - | | Employment agreements | 999 | 1,074 | 1,091 | 104 | - | - | | Purchase Commitments | 4,528 | - | - | - | - | - | ### Critical Accounting Estimates In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), we have adopted various accounting policies. Our most significant accounting policies are disclosed in Note 2 to the consolidated financial statements. The preparation of the consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to inventories, intangible assets, property, plant and equipment, legal proceedings, research and development, warranty obligations, product liability, fair valued liabilities, sales returns and discounts, and income taxes are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, or various assumptions that are believed to be reasonable under the circumstances and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may materially differ from these estimates. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made, and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Our critical accounting estimates include the following: ### Inventory reserves When necessary we maintain reserves for excess and obsolete inventory resulting from the potential inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an ongoing basis. Such marketplace changes may cause our products to become obsolete. We make estimates regarding the future recoverability of the costs of these products and record a provision for excess and obsolete inventories based on historical experience, and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required, which would unfavorably affect future operating results. ### Long-lived assets We review long-lived assets which are held and used, including property and equipment and intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors that are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. (See Note 5 of the Notes to Consolidated Financial Statements) ### Liabilities valued at fair value We generally do not use derivative financial instruments to hedge exposures to cash-flow risks or market-risks. However, certain financial instruments, such as warrants, which are indexed to our common stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within our control. In such instances, net-cash settlement is assumed for financial accounting and reporting purposes, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded, and continuously carried, at fair value. Determining the fair value of these instruments involves judgment and the use of certain relevant assumptions including, but not limited to, interest rate risk, historical volatility and stock price, estimated life of the derivative, antidilution provisions, and conversion/redemption privileges. The use of different assumptions or changes in those assumptions could have a material effect on the estimated fair value amounts. ### Share-based Compensation Under our stock option plan, options to purchase Common Shares of the Company may be granted to key employees, officers and directors of the Company by the Board of Directors. The Company accounts for stock options in accordance with SFAS Statement 123 (R) with option expense amortized over the vesting period based on the binomial lattice option-pricing model fair value on the grant date, which includes a number of estimates that affect the amount of our expense. ### Income Taxes The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using enacted marginal tax rates. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. We have net operating loss and tax credit carry forwards available in certain jurisdictions to reduce future taxable income. Future tax benefits for net operating loss and tax credit carry forwards are recognized to the extent that realization of these benefits is considered more likely than not. This determination is based on the expectation that related operations will be sufficiently profitable or various tax, business and other planning strategies will enable us to utilize the operating loss and tax credit carry forwards. We cannot be assured that we will be able to realize these future tax benefits or that future valuation allowances will not be required. To the extent that available evidence raises doubt about the realization of a deferred income tax asset, a valuation allowance is established. It is our policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. To the extent that the probable tax outcome of these uncertain tax positions changes, such changes in estimate will impact the income tax provision in the period in which such determination is made. At December 31, 2010, we believe we have appropriately accounted for any unrecognized tax benefits. To the extent we prevail in matters for which a liability for an unrecognized tax benefit is established or we are required to pay amounts in excess of the liability, our effective tax rate in a given financial statement period may be affected. Since inception, we have been subject to tax by both federal and state taxing authorities. Until the respective statutes of limitations expire(which maybe as much as 20 years while we have unused NOL’s), we are subject to income tax audits in the jurisdictions in which we operate. ### Inflation Inflation has not materially impacted the operations of our Company. ### Off-Balance Sheet Arrangements We have no off-balance sheet arrangements at this time. ### Recent Accounting Pronouncements See Note 7 of the Notes to Consolidated Financial Statements beginning on page F-14. ## Market risk As filed, 599 characters. Our short-term investments consist of cash, cash equivalents and overnight investments. As such we do not believe we are exposed to significant interest rate risk. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in highly liquid overnight money market investments. If a 10% change in interest rates were to have occurred on December 31, 2010, this change would not have had a material effect on the fair value of our investment portfolio as of that date. ## Controls and procedures As filed, 4,333 characters. ### Controls and Procedures We have carried out an evaluation, under the supervision of and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended), as of December 31, 2010. Based upon that evaluation, our CEO and CFO concluded that, as of the end of that period, our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (b) such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. ### Changes in Internal Control over Financial Reporting Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate annually the effectiveness of our internal controls over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal control over financial reporting in all annual reports. There were no changes in our internal control over financial reporting during the year ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ### Management’s Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: - pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; - provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and - provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. Based on our assessment, our management has concluded that, as of December 31, 2010, our internal control over financial reporting is effective based on those criteria. Filed Mar 31, 2011. Source: SEC EDGAR, the filing index for accession 0001140361-11-019571. Last ingested by Listed: Nov 5, 2026, 13:09 ET. No prices; not investment advice.